Kinh tế vĩ mô Chap 7

1 Introduction to aggregate expenditure model Main idea illustrated by AD – AS model Compare to the idea of classical economists 2 special cases of AD – AS which imply behavior of the ec

Mentor Pham Xuan Truong

truongpx@ftu.edu.vn

Chapter 7 Aggregate expenditure and fiscal policy

1 What is fiscal policy

2 Effects of fiscal policy on the economy

3 Fiscal policy and government budget

Personal and marital life of

Keynes

Maynard Keynes was the son of John Neville Keynes, an economics lecturer at Cambridge University, and Florence Ada Brown, a successful author and a social reformist His younger brother Geoffrey Keynes (1887–1982) was a surgeon and bibliophile and his younger sister Margaret (1890–1974) married the Nobel-prize-winning physiologist Archibald Hill Keynes was very tall at 1.98 m (6 ft 6 in)

well-known Russian ballerina, and they married in

1925 By most accounts, the marriage was a happy one Before meeting Lopokova, Keynes's love interests had been men, including a relationship with the artist Duncan Grant and with the writer Lytton Strachey For medical reasons, Keynes and Lopokova were unable to have children, though both his siblings had children of note

I Aggregate expenditure model

(Keynesian cross point model)

1 Introduction to aggregate expenditure

model

Main idea

The Great Depression caused many economists

to question the validity of classical economic theory They believed they needed a new model to explain such a pervasive economic downturn and to suggest that government policies might ease some

of the economic hardship that society was experiencing.

In 1936, John Maynard Keynes wrote The General

Theory of Employment, Interest and Money In it, he

proposed a new way to analyze the economy, which

he presented as an alternative to the classical

theory Keynes proposed that low aggregate

demand is responsible for the low income and high unemployment that characterize economic downturns He criticized the notion that aggregate supply alone determines national income.

1 Introduction to aggregate expenditure model

Main idea

In the General Theory of Money, Interest and

Employment, Keynes proposed that an

economy’s total income was, in the short run, determined largely by the desire to spend by households, firms and the government (i.e aggregate demand) The more people want to spend,

the more goods and services firms can sell The more firms can sell, the more output they will choose to produce and the more workers they will choose to hire Thus, the problem during recessions and depressions, according to Keynes, was inadequate spending The Keynesian cross is an attempt

to model this insight

I Aggregate expenditure model

(Keynesian cross point model)

1 Introduction to aggregate expenditure model

Other assumptions

+ Prices, Wages and Interest Rate are

Constant: this implies the rigidity of specific market due to objective reasons

+ The Economy Operates at less than full

Employment: this implies that firms are

willing to supply any amount of the good at a given price P In other words, assume that

the supply of goods is completely elastic at price P This assumption is generally valid

only in the short run

I Aggregate expenditure model (Keynesian cross point model)

1 Introduction to aggregate expenditure

model

Main idea illustrated by AD – AS model

Compare to the idea of classical economists (2 special cases of AD – AS which imply behavior of the economy in (very) short run and long run)

I Aggregate expenditure model

(Keynesian cross point model)

Price Level, P

Income, Output, Y

SRAS

A D

Y* Y*'

AD '

AD' '

Y*' '

1 Introduction to aggregate expenditure model

Building model

The aggregate expenditure model which is

illustrated by vertical axis of expenditure

variable and horizontal axis of income (i.e output) variable has two lines

+ Actual expenditure: is the amount households, firms , the government and

foreigner spend on goods and services

(GDP)

+ Planned expenditure (or APE – aggregate planned expenditure) is the amount households, firms, the government and the

foreigner would like to spend on goods

and services

I Aggregate expenditure model (Keynesian cross point model)

1 Introduction to aggregate expenditure model

Building model

The economy is in equilibrium when: Actual

Expenditure = Planned Expenditure (Y=APE) or total income = planned expenditure

I Aggregate expenditure model (Keynesian cross point model)

Planned

expenditure, APE

Income, Output, Y

Actual Expenditure, Y=APE

Planned Expenditure, APE = C + I + G + NX

Y2 Y* Y1

1 Introduction to aggregate expenditure

model

Building model

+ Actual expenditure is the 45 degree line, which

implies the most important identity in the

macroeconomics Total income = Total

expenditure (this is also indicated by computing

GDP in two ways but having the same result)

+ Planned expenditure has 3 properties

* Upward sloping: expenditure is planned to increase

as income increase

* Positive intercept with vertical axis: when income

is zero, the economy still plans to expenditure for

necessaries This level of expenditure is called

autonomous expenditure (the lowest expenditure of the economy, the part of expenditure does not

change as income rises)

* Angular coefficient: has value between 0 and 1 It

indicate normal behavior of economic entity When you have additional income, you will save more and consume more from it

I Aggregate expenditure model

(Keynesian cross point model)

1 Introduction to aggregate expenditure

in turn influence total income and expenditure, moving the economy toward equilibrium.

+ if actual expenditure > planned expenditure: unplanned inventory increases → firms decrease production

+ if actual expenditure < planned expenditure: unplanned inventory decreases → firms increase production

I Aggregate expenditure model (Keynesian cross point model)

1 Introduction to aggregate expenditure model

Expenditure multiplier (by graph)

Consider how changes in government purchases affect the economy Because government purchases are one component of expenditure, higher government purchases result in higher planned expenditure, for any given level of income.

An increase in government purchases of ΔG raises planned expenditure by that amount for any given level of income The

equilibrium moves from A to B and income rises Note that the

increase in income Y exceeds the increase in government purchases ΔG Thus, fiscal policy in particular and total expenditure change in general has a multiplied effect on income.

I Aggregate expenditure model (Keynesian cross point model)

Planned expenditure, APE

Income, Output, Y

Actual Expenditure, Y=APE

Planned Expenditure, APE = C + I + G+ NX

I Aggregate expenditure model (Keynesian cross point model)

1 Introduction to aggregate expenditure

model

Expenditure multiplier (by logical sequences)

I Aggregate expenditure model

(Keynesian cross point model)

Round N. Spending in This Round Cumulative Total ΔI

Assume that people save 20% and consume 80% of their additional income

(0.8 plays the role of b)

● 

I Aggregate expenditure model (Keynesian cross point model)

I Aggregate expenditure model (Keynesian cross point model)

2 Mathematical form of aggregate

expenditure model

+ I - investment: in this model we will take

investment as given or, in other words, we

will regard it as an exogenous variable The main reason for taking investment as given

is to keep our model simple and follow the

concept proposed by Keynes animal spirit

This concept implies current investment

depends on expectation on future (e.g future

profit)rather than current income Y

Therefore

I Aggregate expenditure model (Keynesian cross point model)

2 Mathematical form of aggregate

expenditure model

+ G – government spending: in this

model, government spending also is given as

an exogenous variable The reason is that

government spending depends on various

factors such as social welfare, national

security and of course economic situation To

a certain extent, we can consider

government spending does not depend on

current income Y

I Aggregate expenditure model (Keynesian cross point model)

2 Mathematical form of aggregate

expenditure model

+ NX – net export (X – M): in this model,

export also is given as an exogenous

variable The reason is understandable as

export of a country does not depend on

income of person in the country (however

opposite way could be true) Import, on the other hand, is treated as endogenous

variable due to import’s dependence on

income

where MPM is marginal propensity to import, which indicate how much import increases as income rise one unit

I Aggregate expenditure model (Keynesian cross point model)

I Aggregate expenditure model (Keynesian cross point model)

I Aggregate expenditure model (Keynesian cross point model)

I Aggregate expenditure model (Keynesian cross point model)

Economy Tax Expenditure

Math problems

1 Close economy with government has

following data

= 300 MPC = 0,8 = 200 = 300 t = 0,25 (25%)

a Find consumption function of household,

planned expenditure function of the

economy, autonomous expenditure

b Find output at equilibrium

c If government spending increases by 200,

find the new equilibrium output

d If government would like to have output at

2500 Find the value of G

2 Open economy with government has following data

a Find consumption function of household,

planned expenditure function of the economy, autonomous expenditure

b Find output at equilibrium

c If government spending increases by 20 and

investment increases by 5, find the new

equilibrium output

d If government would like to have budget

balance Find the value of G

Math problems

3 Open economy with government has following data

a Find consumption function of household,

planned expenditure function of the

economy, autonomous expenditure

b Find output at equilibrium

c If government spending increases by 100 and

tax increases by 200, find the new

equilibrium output

d If government would like to have trade

balance (NX = 0) Find the value of G

Math problems

3 Aggregate expenditure model and

aggregate demand

Change in price level

Change in price level will affect C, I, NX by

wealth effect, interest rate effect and

international trade effect (see aggregate

demand curve)→ shift of planned

expenditure curve → move along a AD curve

I Aggregate expenditure model (Keynesian cross point model)

3 Aggregate expenditure model and

aggregate demand

Change in other factors

Change in other factors not price level → shift

of planned expenditure curve → shift of AD

II Fiscal policy

1 What is fiscal policy

Fiscal policy is the policy of government to

use taxation and government spending to

regulate aggregate demand

There are two types of fiscal policy

+ Expansionary fiscal policy: government

raises spending or/and reduces tax

+ Contractionary fiscal policy: government reduces spending or/and raises tax

In economy, there is mechanism to

automatically change government spending and taxation in accordance with the situation

of the economy It is called as automatic

stabilizer Two pillars of automatic stabilizer

are unemployment subsidy and income tax system

2 Effects of fiscal policy on the economy Expansionary fiscal policy

II Fiscal policy

Effects: output increases (unemployment rate decreases), price level rises (inflation rate increases)

Apply: when economy is in crisis, output declines and unemployment rises

P

Y Y

A

AD AD’

APE APE

’

2 Effects of fiscal policy on the economy Contractionary fiscal policy

APE

APE

’

Y

2 Effects of fiscal policy on the economy

When economy is in boom, government

spending decreases and tax collection increases automatically (government has to pay less for

unemployment subsidy automatically by labor

law and enjoys automatic increase in income tax collection by income tax law) = contractionary

fiscal policy

II Fiscal policy

3 Fiscal policy and government budget

Government budget total sum of revenues

and consumption of government in given

time (one year)

BB= T – G

Fiscal policy can reach following objectives

+ Budget balance but Y can fluctuate

(budget prioritized fiscal policy)

+ Potential output Y* but budget deficit can

happen seriously (in time of crisis) (output

prioritized fiscal policy)

II Fiscal policy

+ BB= 0: Budget balance

+ BB> 0: Budget surplus

+ BB < 0: Budget deficit

3 Fiscal policy and government budget How to reduce budget deficit

- Increasing tax revenues and decreasing government spending

- Issuing Government bond

- Borrowings from foreign countries or

international organizations

- Printing money or using reserve from

foreign currency

II Fiscal policy

Key concepts

• Aggregate planned expenditure

• Keynesian cross point model

• Endogenous variable, exogenous variable

• Expenditure multiplier, multiplied effect

• Marginal propensity to consume, marginal propensity to import

• Expansionary fiscal policy, contractionary fiscal policy

• Automatic stabilizer